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Partnership Late Filing Penalty – Rev Proc 84-35 and TEFRA

I have written two prior posts on this issue, and there has been a lot of discussion and important contributions from readers, so I wanted to compile all the information in one post.

The Basics:

Partnerships and entities taxed as partnerships (LLC, LLP, etc) are required to file annual returns by 4/15. A five month extension is available, making the final deadline 9/15. Strict penalties are assessed by the IRS if you file late.

The penalty is currently $195 “per partner, per month” that the return is late. This can add up really fast, and average late filing penalties result in several thousand dollars of non-deductible fees that the IRS is making more and more difficult to get removed.

It does not matter if your business taxed as a partnership did not make any money or never really took off – if you registered for an EIN# or have filed previous returns, you need to follow through and returns annually. The IRS is not going to listen to they type of excuses.

Abatement Option #1 – Rev Proc 84-35

If the partners or LLC/LLP members filed their personal returns timely (4/15 or extended and filed by 10/15), then you may have a get out jail card that has been available for over a decade now and provides automatic penalty abatement.

Here is the complete list of factors:

The partnership has to be a domestic partnership,

have 10 or fewer partners (husband and wife and their estate are treated as one partner),

all partners have to be natural persons (other than a nonresident alien) or an estate of a deceased partner,

each partner’s share of each partnership item has to be the same as their share of every other item,

all partners need to have timely filed their income tax returns, and

all the partners need to have fully reported their share of the income, deductions, and credits of the partnership on their timely filed income tax returns.

Now, it seems the IRS has grown tired of Rev Proc 84-35 abatement requests, as they have been trying to shift the discussion of penalty abatement to “reasonable cause”. Do not let them do this! Rev Proc 84-35 is available if you meet the criteria. Even if you have claimed it several years, do not let them try to claim that they cannot abate the penalty or get you side-tracked with a reasonable cause argument – stick to citing Rev Proc 84-35 until you get your abatement.

Important! This does not work for S corporations and LLCs taxed as S corporations. A similar Rev Proc for automatic abatement was unfortunately never created for them. For more information, read my post on S corp late filing abatement.

Abatement Option #2 – The TEFRA Complication

A few years ago, the IRS was looking to raise revenue (they have lavish parties in Disneyland to pay for) and employed a new tactic to reduce partnership late filing penalty abatements. They found that if a partnership had filed a TEFRA election, that they would not be eligible to use Rev Proc 84-35 to request abatement. Suddenly, many CPAs who submitted standard Rev Proc 84-35 abatement requests were receiving denials with the IRS claiming the client had filed a TEFRA election.

For all the background on this complication, read my penalty update blog post, but the short story is that the IRS would claim the election was filed clear back in 2002 or earlier, and the client had to dig up a copy of the tax return to prove the election was not made or put together a letter – signed by all partners/members – stating that a TEFRA election had never been filed. Even then, it often took many letters back and forth or messages on the now defunct IRS eServices resolution service.

I have personally dealt with this issue several times and was able to get abatement in each case; however, I have not had to deal with it in over a year. Fortunately, some PDXCPA blog readers have had some more current experience, and there was really good information shared in the comments section of the prior posts. Specifically, Melissa F. Hill, CPA provided a sample abatement letter and backup documentation that became a popular request on this blog. The documents she has been emailing to readers are available below:

I like Melissa’s sample letter, as that is how you should frame you argument – cite Rev Proc 84-35 and then maintain that a TEFRA election was never filed and request they provide their proof of the election. A letter signed by all partners maintaining that the election has never been filed helps as well.

Sometimes they will respond with a tax year that they claim the TEFRA election was made in, but then they will claim that it will take them awhile to get a copy from archives. If you are organized and have a copy of the return, send them a copy and continue to maintain your assertion that the election was not filed and that Rev Proc 84-35 should apply. You may have to be persistent and put up a strong fight for abatement, but keep trying and do not let them bring up reasonable cause.

In your personal experience, will the IRS enforce the late filing penalty to begin with for an inactive partnership filing a zeroed out less than 60 days late? Thanks in advance for any insight you can provide!

Doing some research on small partnership exceptions and am having a hard time finding anything to indicate if you qualify for the small partnership exception do you still have to file a partnership return? If the IRS gives a penalty abatement under Rev Proc 84-35 do you still need to file the return?

Brian, You made a number of good point. I disagree on two points though:
1) form 1065 does not have to be filed generally if the domestic partnership/LLC neither receives income nor incurs any expenditures treated as deductions or credits for federal income tax purposes.

The LLC-partnership clarification was added very recently.

2) the TEFRA argument is a Red Herring. IRS has misinterpreted the scope and purpose of section 6231(a)(1)(B). Section 6231(a)(1)(B) was enacted as part of TEFRA in an effort to provide unified partnership audit and litigation procedures. These procedures are completely unrelated and have no bearing on the application and scope of section 6698.

In support of my claim, please see advisory No. 200135029 dated 8/31/2001 from the Office of Chief Counsel which discusses and clarifies that regardless if a section 6231(a)(1)(B) election was made or not, that the criteria for penalty waiver is that the taxpayer is a domestic partnership comprised of 10 or fewer partners, etc. as stated in Rev. Proc. 84-35.

Thanks for the comment. True, you do not technically need to file if there are no income, deduction, or credit amounts, but I rarely ever see such a case in real world situations. Usually, there is always some amount of depreciation expense from assets purchased in prior years, or at least some balance sheet activity and changes to capital accounts – which I personally believe should always be reported. I get really frustrated with tax preparers who take shortcuts when preparing 1065 returns and do not report the balance sheet on Sch L. It only creates problems and more work for the client down the road, and it is just lazy of the tax preparer, as you should take a balance sheet approach to make sure the income/expense data is correct.

Thanks for the recommendation on advisory No. 200135029 – I will check it out. The IRS has misrepresented much with this whole issue, but when you are dealing with them, you are often dealing with a agent who has been trained on specific procedures and is not going to waiver on their position, so for practical purposes I found it much easier just to prove to them that no TEFRA election was made. If I end up with some spare time someday, I will take up arguing with them about it, but last time I tried that there was shouting on both ends and they refused to acknowledge they were wrong. Oh well, back to the returns…

I sent the letters to the IRS siting the Rev Proc above and they have just come back with a reply that says only that at this time “we are unable to consider your request for penalty relief based on rev proc 84-35 criteria at this time” that is it any advise.

Any thoughts on the IRS reaction to an abatement request where I can answer all of the questions as yes except the proportionality question. My partner and I are 50/50 except that I signed personally on the debt. The LLC/partnership has negative equity so he has no basis to deduct the loses so they all go to me.

I don’t believe so. If you look at Section 6698 (c), it clearly states that the penalty is assessed against the partnership. However, I have seen the IRS collection dept assess W-2 and 1099 late fees to owners by structuring them as civil penalties, so I guess it could be possible if they really wanted to go after collection of the penalty. I believe some commenters on my blog had success when notifying the IRS that the partnership was already dissolved and had no remaining assets, so I would definitely try that angle.

Two questions if you happen to catch this. I am just starting the battle of a claimed 1997 TEFRA ( or “elected consolidated audit procedures”.) Q1) #5 of the requirements-Each partner’s share of each partnership item is the same as his share of every other item? Must all Profit, Loss, & Capital be 50/50 or 33/33/33, or 25/25/25 on the K-1? Q2) For all 4 late years I am working on none of the partners (husband, wife, 2 children) never owed tax, nor had a refund coming. What is their deadline for “timely filed”? Due date + 2 years for refund?

As to Q1 – it just means you have to share each item of flow through income, deduction, and credit based on the same %. You can have different capital % and your income/loss percentage, so that shouldn’t be a problem. I have never had this requirement cause me problems, because even if we make some special allocations to arrive at the net number, we still report so that each item is based on the same %.

For Q2 – timely filed would be 4/15 without extension and 10/15 with extension, so if they did not file by the deadline, the IRS could disallow abatement. That I have confirmed in when talking with the IRS, so I do not think that meeting the statute of limitations is going to work.

If you cannot get abatement under the Rev Proc, you may just have to try reasonable cause. Multiple years are tough to get abatement, but I would try every option available.

I used Rev Proc 84-35 today and it worked. I was so ready to present my case over the phone, all the back up material lined up in front of me, but I did not have to agrue at all. I just mentioned 84-35, she put me on hold for 5 min and came back with 5 questions, asked me and we were done. $4,680 penalty went down to zero.

Hello Inna, can you please share with us what back up material that you had presented, for example, your reasoning? What were the 5 questions she asked? I could not get through the phone line. Did you have to try many times and waited long time? Anja.

The only thing holding my partnership back on the abatement due to Rev Proc 84-35 is that the two partners of the partnership did not timely file their individual income tax returns. In fact those returns were years late and one partner still owes taxes on some back years.

1) Would Rev Proc 84-35 apply in this partnership case?
2) If not Rev Proc 84-35, what other reasons for abatement could we make for these steep non filing penalties?

Based on my experiences with the IRS and Rev Proc 84-35, I am not sure they do much research before granting abatement. In fact, several agents stated that they can reverse abatement if they later find that partners filed late, which tells me they do not even check when granting abatement.

Would be tempting just to file it to see if it will go through. If not, have the late filing partners pay since they ruined an automatic abatement.🙂

Sorry, it is a frustrating penalty to deal with. They need to modify the rules for situations like yours and break the penalty up between each of the partners, and then make individual abatement based on if you filed timely. It would be an easy split since the penalty is based on number of partners. Then just have it convert to a civil penalty for the people who can’t get it together in 10 and 1/2 months.

Hi,
I have been using the Rev Proc for a few years but have always had one question. If the individual partners filed their returns late BUT were due a refund on their returns, would the late filing be a reason not to allow the Rev Proc? The IRS has turned me down because of this in the past but I have never been able to clarify it.

In my experience in talking with agents about the timely-filed partner return requirement, it seems to be a very black/white issue to them. If filed by April 15th or extended and filed by Oct 15th = timely filed. I doubt refund status is going to change that, as technically a return filed after extension due date is late even if there is no balance due. There may be no failure to file or pay penalties involved with such a return, but it is still late.

That is why I have 1040 partners file on 10/15 regardless. Even if we have to turn around and amend a month later, it is still a better position to be in than having to worry about this penalty.

Now, if I have a partner that filed a late 1040 with a zero balance due because of a major business collapse or some other reasonable cause, than I am going to fight hard with the agent if the timely filed issue comes up. However, if there is no reason other than the client just procrastinating, then the IRS has a good point on the timely filed requirement.

We plan to attempt getting penalties abated for four years of late filed partnership returns. We meet all of the criteria of Rev. Procedure 84-35 with the exception of one questionable factor. Our partners timely filed their individual income tax returns, however, they did not report their share of income, deductions, and credits of the partnership on their timely filed returns. This information was included on amended partner returns once it was brought to the company’s attention that 1065s should have been filed and K-1s issued.

Is it likely that this fact will disqualify us from successfully using the Rev. Proc. 84-35 argument?

I have the same question… several years worth of late partnership returns for a new client. The partners did not report their share of the passthrough income/deductions on their original returns… Can we still benefit from 84-35?

Would a Grantor Trust that owned limited partnership interests qualify as a “natural person” entitled to abatement? I am referring to a Grantor Trust established by a parent for his wife and 3 children.

In this case the Trust is a limited partner and there are fewer than 10 trust beneficiaries. looks like trusts that hold annuities are considered natural persons, but the trust i refer is a limited partner of a real estate partnership.

My partner and I started and dissolved an LLC in 2013. We could not get the company operate and make any penny. The whole 10 month we had no transaction. Income was zero. Ne expenses were incurred. We had no assets, no bank account. We dissolved the LLC in our state but totally forgot to file form 1065 as everything was clearly zero anyway. Indeed, we filed neither initial return nor final one. Now, I am wondering whether we need to file a late 1065 for the year 2013 (by checking both initial and final return box)? I see one comment above that if there is no activity, i.e. zero income zero expense, 1065 does not need to be filed. Is that true? If so, how should I report dissolved LLC to IRS without getting a penalty for filing 1065 late? Should we just let it go and do nothing? I feel like IRS need to know that our LLC does not exist anymore. Please advise.

Our 4-member LLC is comprised of 2 married couples. We have had a CPA file our joint returns, and because we also submitted our Schedule K-1 for them to include in the 1040s, we were of the understanding that they had filed our Form 1065s all these years, only to realize that they had not done so. Would we be able to invoke Rev Proc 84-35 in this instance, since we have reported our profits and losses in our personal returns?

Great post. My partnership of two had zero income and zero assets. We both filed our taxes on time, however did not report this “zero” income (ie: put no mention of partnership on the tax return as due to it being an assetless incomeless LLC) on our tax returns. Do we still qualify for the abatement or are we technically disqualified? Thanks!

Dear Brian, I just received $11310 penalty on my LLC-Scorp with 0 income. I did not file 1120S because I did not know I still must file the return for 0 income years.
My question is:
is this penalty charged onto the LLC, or onto me personally?
Could it be possible for IRS to seize my personal asset to compensate the penalty?
The LLC has no asset. If I don’t pay the penalty, what would be the consequence, besides the interest on the penalty will continue grow.

There are so many people tortured by this unreasonable new rule introduced in 2008 while we small business owners are not well informed about it. Is there a nation wide small business union that could speak for us? Thanks. Anja

I’m about to fight the IRS on a penalty assessment for late filing of a short year return. The short year was the result of a technical termination of the partnership resulting from one partner buying out the interest of the only other partner. (Rev Rul 99-6). I am expecting the IRS to invoke the TEFRA exception to the small partnership Rev Proc 84-35 regime. Why? Because I’ve been completing the TMP (Tax Matters Partner) designation of ALL of my partnership returns, thinking all partnerships had to make the designation. I should have read the instructions. I’m sure the IRS will use the TMP designation to assert the partnership made a TEFRA election. None of my partnerships ever made a TEFRA election – period. Very interesting comment though by Colin M Cody, CPA citing the irrelevance of TEFRA to this situation – and I completely agree. And I am going to delete the TMP designations in my tax software input.

I work for the service and the listing is NOT complete that you are giving. Many if not all 84-35 requests using your recomendations will and should be denied. You are missing 1 element. irm 20.1.2.3.3.1(2)(d)

Not sure if it prevent the IRS from still trying to use the tactic they have been using with TEFRA, but worth a shot I guess. I just tried it on one I wrote today.

By the way, I haven’t had a chance to read up on it, but from what I have heard, TEFRA was repealed for years beginning after 12/31/17 by the Bipartisan Budget Act of 2015, so hopefully we will not have to deal with this issue much longer.

I believe that the IRS is assuming that the partnership elected TEFRA provisions IF the Tax Matters Partner section on Form 1065 has been completed. A “tax matters partner” should only be designated on 1065 if the partnership has elected to be subject to the TEFRA provisions. I and many other preparers have been completing the TMP questions thinking that ALL partnerships must complete the TMP section. I think the IRS is assuming that TEPRA applies if TMP entries are present on the 1065 in question. However completing the TMP info does NOT constitute a TEFRA election. See the following:

From the beginning of Chapter 13 (TEFRA) of the IRM – under 2nd heading, “IDENTIFYING THE TEFRA PARTNERSHIP”:
CAUTION: For 2004 and subsequent tax years, checking the “yes” box on question #4 of Schedule B of Form 1065 which asks the question, “Did the partnership file Form 8893, Election of Partnership Level Tax Treatment, or an election statement under section 6231(a)(1)(B)(ii) for partnership-level tax treatment, that is in effect for this tax year?” does not constitute a TEFRA election. For tax years prior to 2004, checking the “yes” box on question #4 of Schedule B of Form 1065 which asks the question, “Is this partnership subject to the consolidated audit procedures of sections 6221 through 6233?” also does not constitute a valid TEFRA election. Nor does the identification of a TMP at the bottom of Schedule B, in and of itself, constitute a proper TEFRA election.
CAUTION: In instances where the partnership would not appear to qualify as a TEFRA entity but still designates a TMP on the Form 1065 or responds positively to question #4 on Schedule B, the examiner should inquire as to whether there is a TEFRA election in effect. The examiner should secure the partnership’s file copy of the election and determine if the election is valid under Treas. Reg. section 301.6231(a)(1)-1(b)(2). If the election is determined to be invalid, the partnership is not a TEFRA entity. If the election is determined to be valid, attach a copy of the election to the partnership tax return and document this fact in the case file.

Please note further that as a preamble, IRM 20.1.2.3.3.1(2) states “Rev. Proc. 84−35 provides that reasonable cause for filing a late or incomplete return will be presumed for certain small partnerships if certain criteria are met:”

Yet, a careful review of the actual verbiage in the Rev Proc. 84-35 reveals that this claim of a necessary criteria as stated in the IRM is unsupported… it is false.

Further to this point, the Office of Chief Counsel was aware that the IRS occasionally incorrectly took this TEFRA position going back several years and in CCA 200135029 LAW & ANALYSIS https://www.irs.gov/pub/irs-sca/0135029.pdf they felt “compelled to note” that such a position is “completely unrelated and [has] no bearing on the application and scope of section 6698.”

Agent Smith, if you would please – I would appreciate your response, and if you agree that the Rev. Proc. does not mention TEFRA and more importantly, if you agree with the Chief Counsel’s explanation of the law, explain how the IRM can be revised to properly comply with the law and congressional intent in this matter.

The request must include all 5 elements. This is even included it the penalty letter that is sent that no one actually reads. We are not allowed to the grant the 84-35 if the request is not complete and must include a – e as outlined in irm 20.1.2.3.3.1(2)(a)(b)(c)(d)(e). If its not all there its an automatic denial.

I filed my partnership 1065 last October 15 because I was convinced that I could do so since the partnership reported a loss for the year and I filed a refund 1040 return. I filed both the 1065 and the 1040 (for my wife and I) on October 15. We fulfill all the requirements for Rev Proc 84-35 but I’m not sure whether a refund 1040 return filed on October 15 is considered a “timely filed” return for Rev Proc 84-35 purposes. Any advice anyone?

Thanks for your reply Brian. Unfortunately we fall under the second case: we did not file for a 1040 extension on 4/15 (again because I didn’t believe that we needed to). Does the IRS make any exception to this rule, considering that we even dissolved the LLC within it’s first year of operations (yes it was doing that bad)? Since we are first time offenders, do we qualify at least for an FTA abatement?

Thanks for your reply kmg4. As a matter of fact we haven’t requested any abatement yet. Tomorrow my wife and I will go to the local IRS office to discuss what can be done to remove or abate the $2,730 penalty that they charged us. I also requested an appointment with the local Taxpayer Advocate Service. If we don’t qualify for Rev Proc 84-35, I hope that we can qualify for an FTA. This is our first (and last, since our LLC is already dissolved) year of operation, so we never took advantage of any FTA before. If not, I hope that we can qualify for some sort of reasonable cause, as this was the first time we had to deal with the complications of filing the 1065, the K-1s, depreciation forms etc. Back in April I read in the confusing IRS forms that partnership’s income (or loss) is not directly dealt with in the partnership’s return, but it is passed along to the individual member’s returns. Since I knew that we were going to file a refund return in our 1040, and that filing an extension for a refund 1040 is not necessary, I thought that indeed it was ok not file the extension, not knowing how the individual’s 1040 and the partnership’s 1065 were linked together. We made a mistake in good faith, we were not trying to trick the IRS. I hope we can get the huge penalty removed, otherwise we are screwed.

David, Rev Proc 84-35 is a bit sophisticated and there are nuances that might need to be argued. And besides, in your case, you failed to meet to strict requirements for this reasonable cause abatement procedure. So forget it.

Rev Proc 84-35 is just ONE reasonable cause to consider for abatement. You could have another reasonable cause to have a penalty abated. As you say you didn’t know any better, well that in itself might be a reasonable cause.

But you should forget the reasonable cause method altogether at this time.

And visiting the IRS is probably not necessary or desirable. A letter seeking FTA is all that should be necessary. My understanding is that even if Rev. Proc. 84-35 would apply or even if another reasonable cause would apply – that the FTA takes precedence. FTA is basically totally automatic, just for the asking.

You were right Colin. All I needed to do was call the IRS business line, tell them the EIN number of my company, request the FTA, and the penalty was removed. The hardest part of the phone call was the long wait on hold (over an hour). Thank you very much for your advice. I really appreciate it.

I filed my 1065 on Sept 15, the correct day. I sent the K-1 to both partners (myself and the non-profit that owns 99%) on the same day.

BUT, I did not know that I had to include K-1s with the 1065. Instead, I included them with my personal 1040, and the other partner did the same.

Now, the trouble..

I got a letter 3 months later (now), saying that since I did not include the K-1s with my 1065, I owe penalties of $1170.

This is far more than the income of the partnership (which is just $9 to me and $891 to the non-profit). The penalty literally dwarfs the taxable partnership income.

I didn’t know that the K-1 had to be with the 1065, rather than with the individual returns. This was very unclear in IRS literature, especially since the K-1 is not in the same .pdf as the 1065.

Even worse…

I used up my first-time abatement last year (the first year I ever filed), since I filed thinking the deadline was Oct 15 (like with the 1040), rather than Sept 15. I got the abatement, but that may have used up my first-time abatement.

So to summarize,
1) I filed the 1065 on time. But I included the K-1s with the personal return, not the 1065.
2) The penalty levied is steep, as they waited 3 months.
3) I used up my first-time abatement last year…(unless it was 84-35 and not FTA).

What do I do? I can write the same sort of letter as last year (and send them copies of the K-1s, which they already have under my personal 1040). BUT, since I may have used up my FTA, *and* the other partner is a 501c3 non-profit, rather than a natural person, what do I do?

kmg4, Did you get the 2013 Form 1065 filed and accepted without Schedule K-1s? No complaint from the IRS about the missing K-1s? IRS just complained about the October 15, 2014 filing date?

If so, then write to IRS and say that you have a reasonable cause and please abate to 2015 penalty. As follows:
1) you properly prepared the K-1s but you mistakenly attached the Sch K-1 to the Form 1040 and the other non-profit tax return.
2) you believe you were doing this correctly because the IRS accepted the 2014 Form 1065, and From 1040 and Form XXX without any problems regarding the K-1s, so you expected the IRS would likewise accept the 2015 Form 1065 without any problem.
3) You are now aware of your misunderstanding, and will file appropriately going forward.

I have received a penalty for late filing a partnership return and would qualify to use the rev proc 84-35 but my share of ownership and profits are not equal. My brother has 50% of the capital but 0% of the profits since he has moved out of state. I plan on transitioning the business from a partnership to a sole proprietorship but haven’t done so yet. Please help ASAP!

I filed my partnership return late and would qualify to use the rev. proc. 84-35 but my ownership and income categories aren’t equal. My brother has 50% of the capital but claimed 0% of the profits, since he has now permanently moved out of state. I want to convert the partnership over to a sole proprietorship but have not done so yet. I have also used up my first time forgiveness leeway with the IRS by making a mistake in the past. Please let me know if there is anything I can do, I really need some advice.